A "steady" Philippine economy would allow the peso to further strengthen to the ₱54:$1 level before year-end, despite lingering downside risks from local politics as well as external economic and financial developments, according to Japanese financial giant MUFG Bank Ltd.

In a May 27 report titled "Philippines: Steady as she goes," MUFG Global Markets Research senior currency analyst Michael Wan said he expects the Philippine peso to settle at ₱55.6 against the United States (US) dollar by the end of the second quarter, before strengthening to ₱55 versus the greenback in the third quarter, and appreciating further to ₱54.5 in the fourth quarter until the first quarter of next year.

This is on the back of MUFG's expectations of medium-term US dollar weakness spilling over to early 2026, Wan noted.

"Beyond global factors, it is important to continue highlighting the Philippines' specific drivers underpinning our expectation for modest peso strength," he said, namely: manageable inflation that would lead to downward interest rates, a possible Philippine-US trade deal to lower the initial 17-percent reciprocal tariff, as well as anticipated improvements in foreign direct investment (FDI) and the government's ambitious infrastructure rollout plan.

MUFG forecasts headline inflation to fall to an average of 1.8 percent this year—below the two- to four-percent target band of annual consumer price increases conducive to economic growth—"driven by lower domestic rice prices, good global rice supplies, manageable oil prices, coupled with lower upside risks to transport fares and electricity prices."

For MUFG, this would allow the Bangko Sentral ng Pilipinas (BSP) to remain dovish and slash key interest rates by an additional 75 basis points (bps) to bring the policy rate to 4.75 percent before 2025 ends, from 5.5 percent at present.

"We also pencil in a 100-bp reserve ratio requirement (RRR) cut in the fourth quarter of 2025, which could boost domestic liquidity by around one percent of deposit base in the Philippines' banking sector," Wan said.

"While the timing of these forecasts is somewhat faster than what BSP Governor [Eli] Remolona [Jr.] has publicly mentioned recently (two rate cuts by 2025), we think lower inflation pressures should provide the central bank space to continue its rate cut cadence this year," he added.

Adding to MUFG's more bullish peso outlook is the possibility of a US-Philippine agreement to lower the previously announced higher import tariff to be imposed by America on goods from the Philippines.

"We think a deal is not difficult to be reached given the Philippines only has a very small trade deficit with the US of around $5 billion, together with low perceived indirect supply chain linkages with China in its US exports," Wan explained.

But Wan cautioned about "some risks on upcoming semiconductor and electronics tariffs, which could impact the Philippines."

However, MUFG believes that such tariffs would "[focus] on segments that the US wants to reshore such as higher-end semiconductors and AI [artificial intelligence] chips, and as such the Philippines should still come up relatively better off," he said.

While foreign investment approvals have been reported to have slowed at the start of the year, MUFG sees actual FDI inflows improving to reflect the surge in investor commitments in recent years, especially in renewable energy (RE) and sectors liberalized by laws enacted by the previous Duterte administration before it stepped down in 2022.

"Although FDI approvals have now fallen closer to $8 billion, the key for the Philippine peso is that we should start to see some improvement in actual FDI over the next few quarters if the historical relationship between approvals and implemented capital holds," Wan noted.

"With a relatively large current account deficit of around 3.5 percent of GDP [gross domestic product], this will be important in helping the Philippines fund its current account deficit amid rising import needs, and hence supporting the Philippine peso," he said.

The "Build Better More" infrastructure push, alongside stronger public-private partnerships (PPPs) with a pipeline equivalent to about 13 percent of GDP, would also "continue to support economic activity, and as such also help support economic sentiment."

MUFG forecasts GDP growth this year to match last year's 5.7 percent, although slower than the government's more ambitious target of six to eight percent.

For next year, MUFG projected the economy to grow at a faster pace of six percent.

However, Wan said MUFG sees the peso's relative strength against the US dollar being tempered by rising domestic political risks, as well as the threat to Philippine remittances under a pending US bill.

"In the recent Senate elections, the candidates perceived to be aligned with Vice President Sara Duterte did much better than what polls indicated. With at least five such candidates selected in the Senate, we could see greater political noise moving forward including on an expected upcoming impeachment hearing against the Vice President," he warned.

"Our base case is for the net impact of the recent Senate election results to result in greater political noise, while also importantly slowing the pace of reforms in the pipeline, especially more contentious ones on fiscal and tax policies," he said.

"Nonetheless, we think it is unlikely to change the trajectory of policy including on infrastructure build-out, and as such should not materially change the country's current growth trajectory at least in the near term," he added.

According to MUFG, "the upside in our view is that the risks of political instability and protests have likely somewhat diminished given a more divided Senate, but what's key for the longer term is the shape of the 2028 Presidential elections and possible contenders."

As for the One Big Beautiful bill in the US Congress, Wan warned that "Philippine remittances from the US could be cut by around 0.1 percent of GDP, if the 3.5-percent remittance tax proposal as incorporated in the recently passed US House tax bill is ultimately implemented."

"Remittances from the US make up three percent of the Philippines' GDP, the highest in Asia, and this may weigh on the country's current account deficit to some extent in 2025," Wan said.

"Of course, the band of uncertainty is reasonably wide, and among other things overseas Filipino workers (OFWs) and green card holders in the US could perhaps use informal channels to bypass these taxes. In addition, we note that historically remittances overall have been very resilient to shocks and there may also be some diversification of flows from other regions beyond the US to help offset the remittances tax," Wan added.

MUFG also cautioned against the proposal brought forth by Remolona last week to put in place a point inflation target.

"The timing of the possible policy change is unclear although the BSP Governor mentioned that the proposals should be done by next year. If a two-percent inflation target is ultimately implemented, it would imply a higher bar set for the BSP, and all things equal, should mean stickier and higher interest rates than would otherwise be the case," Wan explained.

"The net impact on the Philippine peso from an FX [foreign exchange] perspective is more mixed, with higher real interest rates but at least partially offset by somewhat slower growth prospects weighing on foreign equity inflows," according to Wan.